Returns On Capital Signal Tricky Times Ahead For E-Commodities Holdings (HKG:1733)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, while the ROCE is currently high for E-Commodities Holdings (HKG:1733), we aren't jumping out of our chairs because returns are decreasing.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for E-Commodities Holdings, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.28 = HK$2.1b ÷ (HK$13b - HK$5.7b) (Based on the trailing twelve months to December 2022).

So, E-Commodities Holdings has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 4.4% earned by companies in a similar industry.

View our latest analysis for E-Commodities Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for E-Commodities Holdings' ROCE against it's prior returns. If you'd like to look at how E-Commodities Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From E-Commodities Holdings' ROCE Trend?

On the surface, the trend of ROCE at E-Commodities Holdings doesn't inspire confidence. Historically returns on capital were even higher at 39%, but they have dropped over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, E-Commodities Holdings has done well to pay down its current liabilities to 43% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for E-Commodities Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 250%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing to note, we've identified 2 warning signs with E-Commodities Holdings and understanding these should be part of your investment process.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.